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Be Careful What You … Measure?

Why should the stock market move in tandem with the price of oil? If you’ve never before heard that it has been you may think that the world really has gone crazy. Of course, you might be right.

But the phenom has been so strong and so enduring, lasting nearly two months now, that it’s more than a bizarre intellectual exercise – there’s a lot of money at stake. So what’s so important about oil going up that it drives the market? And how long will this keep up?

There are a few good theories out there for the first question, none of which make a strong case for when this relationship will break and we’ll go back to “cheap oil is good”. But there may be an even simpler way to look at it which tells us that the current situation can’t hold for very long at all.

The good numbers are always buried.

The good numbers are always buried.

Stocks have been down for all of 2016 for reasons that Barataria has described as “because”. It’s a pause, the theory goes, a welcome break fueled by nervousness over China, retail spending, lower profits, and baggage retrieval system at Heathrow. Every market has to at least take a pause once in a while, and the cyclical bull that’s been running since 2010 was getting pretty old by any measure.

But to hook up with the price of oil? That’s just crazy.

The standard measure of oil is West Texas Intermediate (WTI). This is the price of crude oil of intermediate quality in Cushing, Oklahoma. It’s simply a convenient standard. We’ve written about this many times as Barataria tried, desperately, to tell everyone that oil can’t possibly go below $80, then $60, then $50 per barrel. It’s at about $30 now. Mazeltov.

Demand for oil didn't rise as fast as expected, so supply got ahead of it.

Demand for oil didn’t rise as fast as expected, so supply got ahead of it.

The first concern that moved stocks with oils was the fear that the junk bonds floated to frack the bejaysus out of North Dakota were going to fail. This is still a valid concern, but investors have had more than a year now to price the potential $336B loss into their business. It’s almost certainly taken care of.

Is it possible that robots are to blame?  After all, they learn through AI the patterns of the market and then apply them, which is to say repeat all the bad habits of humans ad infinitum.  It’s an interesting theory that suggests the two will be stuck together for a long time – at least until someone makes a killing going against the ‘bots.

"C'mon ..."

“C’mon …”

Some random blogger named “Ben Bernanke”, writing for the Brookings Institution, has a much more elaborate and good reason. It’s not that stocks are hurt by low oil prices, he tells us, as they are both hurt by the same decrease in demand worldwide. The theory is that reduced demand is what’s killing oil and China both – and will ultimately crash the stock market.

Correlation does not imply causality, so the theory is sound. But it doesn’t check out entirely.

The best Bernanke can correlate stocks and oil going back to 2011 is 0.43, a weak correlation at best. That’s after he takes into account the fact that only 45% of the drop in oil prices can be explained by weakening demand and fudging the whole sundae with a correlation through the volatility index (VIX). Others, looking for the same correlation, found that it only gets weaker if you look back to 2000 or so. There’s no good reason for oil to correlate with stocks other than negatively, as cheap oil is good for consumers.

That brings us to one of the things we know is spooking the market, which is the relatively weak retail sales figures in 2015. The chart below shows the year-over-year change in retail sales since 2000:

Year-over-Year (YoY) growth in retail sales since 2000. Data from the St Louis Federal Reserve.

Year-over-Year (YoY) growth in retail sales since 2000. Data from the St Louis Federal Reserve.

From this, we can see that a healthy economy, circa 2000, sees retail sales grow between 5% and 10% every year. Between official recessions, specifically 2004-2006, we hit that level again. Outside of a rebound after a disastrous 2007-2010, we haven’t been above 5% growth per year. It’s the thing that many point to as holding back GDP growth as the most sensitive part of overall consumer spending figures.  So it’s been watched very carefully for signs of a genuine rebound.

Happy shoppers make for a happy Christmas.

Happy shoppers make for a happy Christmas.

In 2014 it averaged 4.3% growth, but in 2015 only 1.5%. That is bad.

Then again, we have to remember that gasoline is about 10% of all retail sales. A drop in gasoline prices of about 35% will show up as a drop in retail sales of 3.5%, roughly. The figures from 2015 are actually rather strong if you add this back in – a feature we see at the tail end of the chart this January, where we are comparing two post-drop periods for the first time.

So by the middle of the year consumer spending may well be looking like it did back about 2006 or so, which is to say above 5% for the first time that isn’t just a crash rebound.

That’s when we can expect low oil to stop correlating with the stock market. This still points to sometime this summer or so, which is to say when oil prices typically rebound just a little bit for summer driving season.

Whether buying stocks or simply seeing the USA in your Chevrolet, please fasten your seatbelts and have a nice trip!

16 thoughts on “Be Careful What You … Measure?

  1. In Canada the government makes so much money from taxes on oil that they are feeling the pinch. Thousands of people are out of work in the oil fields and that puts demands on our social safety net (more tax dollars gone). They are planning a deficit to stimulate the economy but things are practically coming to a stand still. So our Bank of Canada is keeping interest rates very low to nil because they think businesses will borrow and spend. Our currency has dropped by 30% so our food cost have sky rocked. We have lost faith in the stock market because it has been artificially inflated when the bond holders moved over to equities in order to get a decent yield. We are in for a rough ride.

    • North Dakota has gone completely bust, too. It’s not as bad in Texas and Oklahoma, since everything is more automated, but they are losing revenue. I think Alaska is really in trouble as well.

    • Yes, that’s what I’m saying. And I expect spending on other things to indeed come around this year, as we’ve already seen over the holidays and in January.

  2. You could have stopped here, “Stocks have been down for all of 2016 for reasons that Barataria has described as “because”.

  3. This is an easy one. The trend line downward is the disillusion with Obama and Congress and the federal reserve. Remember the thing about the 1% and suicides by returning war veterans, school shootings, blacks being killed by police. unhappiness about John Boehner and Mitch McConnell.

    Barron’s newsmagazine speculating that Sanders and Trump are affecting the stock.

    My own guess is that non-economic factors in additions to a kind of economic malaise are affecting the stock mar ket.

    After the ecstasy years of rising home values (remember all those smiling faces in Highland Park)and there was the managed depression, the recession ended, Obamacare was signed in March 2010.

    Then there was the realization discussed in the pages of a blogger I once knew by the name of Erik Hare that life will never be quite the same post managed depression. And the reason is that we did not listen to our grandmothers.

    The stories told by Trump and Sanders reflect all this.

    I remember all the bitterness with which you spoke about John Boehner and your lack of defense of Pres. Obama. Obama has sold out liberals told us. John Boehner is a nice man compared to Donald Trump

    Bloggers told us “we don’t have strong leadership.”

    If we all remember in the pages of Barataria there is a sly cynicism and populism that engineers turned economists use to show they are sophisticated. “the federal reserve has too much power” “stock market is rigged” “nothing gets done in Washington except in the courts” “Alan Greenspan was a total political animal” “there are plenty of good ideas not getting funded” “Citizens united” George W committed high crimes” “we need a female federal reserve chair” “the national debt is robbing us blind” “the deficit is coming down so we are okay”

    These mentalities have fueled the rise of a man named Donald Trump.

    : )

  4. You.

    Think about your motto, I dont break news I fix. You are boasting that you have better take on what’s going on than the “mainstream media”

    Every blogger on the internet has that implicit boast.

    That fuels unwarranted cynicism. The reason is you can’t deliver. You cant show that your explanations of economic events, politics, business or policy is better than any else’s.

    Bloggers like yourself, since you have power, tend to be arrogant. “Most of the explanations about the what’s going on in the economy are all wrong.” When you are dismissive of reasonable explanations of the economy you are being arrogant. You are saying “I have the truth, just look at the Fred data.

    Think about your saying ” we need strong leadership.” Some of your readers probably believe you. But the counter argument is we to stop sending a divided government to DC.

    Think of your out of control criticisms of John Boehner. John Boehner is moderate compared to Ted Cruz and Donald Trump. Since you are liberal you should have pointed out the good things about John Boehner to your readers as an olive branch to republicans. Instead you try to show off to your liberal base in Barataria that John Boehner didn’t lead.

    Another example is that you say f ederal reserve just makes up money out of thin air. That isnt true. But some of your rather naive readers who dont understand even basic economics believe this. So you just add to the cynicism.

    You have talked about things Rush Limbaugh has said. But have you used 1 column to explain Obamacare. Did you try to shed light on it? Instead you have endless columns on the stock market and currency wars–big boy topics that don’t help those who dont understand basic economics.

    You show off by seeming to be pro black. But I ask you what is it to be white. You don’t answer.bbbbbbb

  5. Harry,

    So what I seem to gather from your rather obscure commentary is that it is the “those liberals” who have screwed everything up yet again. As for naive that could be a possibility, but then again describing you as obtuse is a possibility as well and I think one that is justified by the confusing state of the allusions in your writing. Here’s the problem: there is a tremendous difference between having intelligence and being able to use that intelligence by allowing oneself to consider differing points of view. For instance Ted Cruz is a very intelligent man, but because he is restricted in his world view, he is immune to evidence contrary to that view. i.e. The government has no business by normative Conservative standards to interfere with a woman’s body. The characteristic of the liberal mind is that it is open to alternatives and not bound by rigid premises. Conservatives in this respect have used the defense mechanism of projection, to accuse liberals of that which they themselves are guilty. Add to it the defense mechanism of denial and you have the mindset of most conservatives today. In that regard, I see you also as an intelligent man, but liberals in general seem to be the log in your eye that prevents you from seeing the world as it is, and not as you would imagine it to be.

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